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Roger Garrison on the Minimum Wage

We never feature guest posts here at the Cafe; that’s been our long-standing policy since our start nearly ten years ago. Below, however, is a post that I asked my friend Roger Garrison, at Auburn University, to write for the Cafe. A few weeks ago Roger sent me a long e-mail in which he spelled out an intriguing angle on the minimum-wage issue. Roger’s insights here, as always, are creative and very much worth pondering. So here’s Roger’s analysis, in bold.

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Minimum Wage: This Time It May Be Different

In all likelihood we’ll soon see another 40% increase in the minimum wage. The most recent increase ‒ from $5.15 to $7.25 ‒ was just over 40%; the Congressional Democrats’ currently proposed increase ‒ to $10.10 ‒ is just under 40%. But would it be better to legislate a decrease in the minimum wage or even to eliminate the mandated minimum altogether?

Let’s assume that the enabling legislation for the currently proposed increase and for the hypothetical decrease is identical to that of the most recent increase except for the particular before-and-after minimum wage rates. For instance, they are all implemented in a stepwise fashion. Now, consider two propositions about the expected consequence of changing the minimum wage:

Proposition 1: Increasing the mandated minimum will cause no more than a temporary increase in the unemployment rate.

Proposition 2: Decreasing the mandated minimum will cause no more than a temporary increase (sic) in the unemployment rate.

Which, if either, of the two propositions is true?

It turns out that both propositions are true. And their truth hinges only on a common ‒ typically implicit ‒ stipulation and on a reasonable judgment.

The stipulation: “the unemployment rate” refers to the measured unemployment rate reported by the BLS on the first Friday of each month. Currently 7.0%, this well publicized rate denotes the percentage of the labor force (a) not currently employed but (b) actively looking for work. (People who are currently employed comprise the other 93% of the labor force.) So, if you’re not currently employed and not looking for work, then you’re not a member of the labor force and you’re not counted as unemployed.

The reasonable judgment: low-skilled workers are not stupid.

When the minimum wage is raised, some low-skilled workers will lose their jobs. And some would-be entry level workers will be unable actually to enter the labor force. Both groups will spend some time looking for work but with little success. Eventually, they’ll stop looking ‒ which is only to say that they’re not stupid. Entry-level jobs that could have paid a wage rate they would willingly accept have been outlawed. Blocked by minimum wage legislation, these people may have to depend on their families or on the government, and/or they may resort to off-the-record baby-setting jobs or lawn-mowing jobs, most likely earning less than the old minimum wage. Worse, they may engage in illegal activities ‒ prostitution, the drug trade or, increasingly, identity theft and income-tax fraud. In all these eventualities, the victims of the increased minimum wage are not counted as unemployed. (It’s true, of course that the slightly more skilled workers will enjoy a temporary increase in their real wage rate.)

If the minimum wage were to be lowered instead of raised, a similar dynamic would be observed. Would-be workers who had been blocked from employment by the old (higher) minimum wage would be back in the market for a job. Young first-time job searchers would spend some time looking for the best-fit job among many jobs that had before been outlawed. And until these job searchers actually take a job, they’re categorized as unemployed: they’re not working but are looking.

In the two cases considered, one involving an increase, the other a decrease in the minimum wage, the unemployment rate temporally rises. But in a critical respect, the cases are direct opposites of one another. After an increase in the minimum wage, people are transitioning out of the labor force (facing a future that is bleak and/or dangerous); after a decrease in the minimum wage, people are transitioning into the labor force (where there are opportunities for gaining skills and moving up the wage-rate ladder).

On first read the proposed increase in the minimum wage seems to be a replay of the most recent increase ‒ including the near-obligatory stepwise adjustment, which will make the job-killing aspect of the transition less dramatic (and hence less newsworthy) and cause the temporary increase in unemployment to be correspondingly prolonged.

A key difference, though, is that the proposed increase (now supported by President Obama) is to include a cost-of-living adjustment. The $10.10 minimum will increase automatically to match increases in the CPI, keeping constant the minimum-wage workers’ purchasing power. All earlier increases in the minimum wage were nominal increases only, allowing inflation to reduce real incomes and hence purchasing power. In the most recent case, the real minimum wage rose as the nominal minimum was raised over a short two-year period (2007-09) and then fell during the past four years, undoing (so far) about half of the previous increase.

This pattern has been evident since the beginning of this country’s initial enactment of minimum wage legislation in 1938. The minimum wage rises with acts of Congress and falls as inflation erodes its purchasing power. What this means, of course, is that the transitioning of people out of the labor force brought about by a rise in the minimum wage is eventually reversed by a gradual, inflation-induced fall in its purchasing power. Now neither the inflation nor the policy-induced “yo-yoing” of the labor force is good for the economy, but if we get the down-“yo,” we’d better hope for the up-“yo.” The current proposal, by stipulating a new minimum in purchasing-power terms, will have a permanent effect on the labor force. It mandates a down-“yo” while blocking the up-“yo.”

There is reason to believe that the proposed indexing will not survive the legislative process. The reason is a simple one: indexing would remove the issue of periodically raising the minimum wage from the Democrats’ political agenda. Most voters, especially those on the left side of the political spectrum, think in terms of intentions instead of consequences and hence are in favor of minimum wage legislation. A nominal minimum wage rate allows left-leaning politicians to harvest those votes about once every election cycle.

Based on the long history of the minimum wage, we should expect to see a new minimum wage, no indexing, and another yo-yo. But based on the President’s and the Congress’s “success” in making ObamaCare the law of the land, we should worry about an indexed minimum wage. That would keep the displaced workers permanently displaced.